We’ve just published a new report arguing that the Bank of England should start issuing ‘digital cash’ – essentially an electronic version of the physical notes and coins we use every day. You can read the summary and download the report here. But how would you be affected if the Bank of England started issuing digital cash?
Currently, members of the public have a choice of using two kinds of money. One – physical cash – is created by the state, via the Bank of England. The other – the electronic money in your bank account – is created by banks as they issue loans. The vast majority of money now consists of the electronic kind created by banks, which means if you want to use any kind of electronic payments, you need to use the money created by the banking system. In fact, since few companies still pay salaries in cash, most people have no option but to use electronic bank accounts.
The central bank actually already issues a form of electronic money, in the form of ‘central bank reserves’ held in electronic accounts at the Bank of England. But these accounts are provided only to banks, building societies and a small number of other systemically-important financial institutions. Members of the public, businesses and even most companies in the financial sector are unable to get accounts or store funds at the Bank of England. Instead, they have to hold their money in the form of deposits at commercial (i.e. high-street) banks. These banks back those deposits with a much smaller pool of electronic money at the central bank, and a much larger pool of risky assets.
We think that the Bank of England should allow everyone – not just banks – to hold electronic money in accounts at the Bank of England. In the report we explain how the Bank of England could introduce ‘Digital Cash Accounts’ (DCAs) in which you could electronically store your money. Because digital cash would be held at the Bank of England, it would be 100% risk-free and never exposed to the risk of a bank failing. But unlike physical cash, which can only be spent in face-to-face transactions, digital cash would be connected to the electronic payment system, so it would be as convenient to use as the money in your bank account.
Of course, the Bank of England wouldn’t want to provide 60 million accounts, plus debit cards and all the customer service that comes with it. So we’ve proposed a way in which private sector firms, called “Digital Cash Account Providers”, would manage the accounts. So you would deal with a DCA Provider to open an account, get a debit card, internet banking, and customer service, but behind the scenes, the money would always be stored safely at the Bank of England. You would always own the money in your account; the DCA Provider would just provide you with a useful and customer-friendly way of using that money to make payments. This is in contrast to the existing banking system, where instead of owning the funds in your account, you simply have an IOU from the bank.
DCA Providers wouldn’t be allowed to lend the funds in your account, or place them at any risk. So whereas the government has to guarantee normal bank accounts (up to £75,000 per customer per institution) in case the bank takes too much risk and fails, money stored in a Digital Cash Account would be guaranteed up to any amount by virtue of the fact that it would be stored at the Bank of England (which will only ‘fail’ if the entire government and state collapses).
There is one downside: because the DCA Provider can’t earn interest by lending or investing your money, it has to cover its costs in other ways. So Digital Cash Accounts are very likely to charge fees on either a monthly or per-transaction basis. However, that’s not necessarily a disadvantage: because a DCA Provider has to tempt customers away from the existing banks, they’ll probably focus on providing much better customer service, better ways of making payments, and better ways of managing your money. It’s also worth remembering that bank accounts with the existing banks in the UK aren’t truly free; the bank intends to recover its cost of providing accounts through lending to you at some point in the future.
So by issuing digital cash, the Bank of England would give the public a choice between the electronic money created by the banks, and electronic money created by the state. You could effectively ‘opt out’ of using bank-issued money.
Digital cash could also provide the Bank of England with a new way of implementing monetary policy. Ever since the crisis, policy makers have been trying to find a way to increase employment and help the economy to recover. But most of their policies have failed. Lowering interest rates to close to zero was intended to increase borrowing, but because people were already in so much debt and couldn’t afford to borrow more, this didn’t work as well as they had hoped. Quantitative Easing – the creation of £375 billion of new money by the Bank of England – had the effect of inflating financial markets and increasing the wealth of the already wealthy, but had little effect on spending in the real economy.
Clearly the Bank of England needs a new tool of monetary policy: something which will increase spending in the real economy, without increasing household debt or artificially inflating financial markets. Digital cash allows it to do this quickly and effectively. Provided that every citizen has at least one Digital Cash Account, the Bank of England would be able to credit each account with an equal amount whenever it is necessary to stimulate the real economy. This policy is sometimes referred to as ‘helicopter money’ or a ‘citizen’s dividend’, and it’s getting more and more support from high-profile economists. Digital cash means that helicopter money can be implemented in small amounts, for example on a monthly basis. There’s a lot of evidence to suggest that this policy would be better and safer than the strategies the central banks have been using until now.
Issuing digital cash has other significant benefits for the economy and for financial stability. These are outlined in detail in the report, but in brief:
- It can make the financial system safer: Since anyone who wants to make electronic payments (including large corporations and financial sector firms who often need to transfer tens or hundreds of millions at a time) currently must use bank deposits to make payments, the failure of one large bank can be catastrophic. This is one of the reasons why large banks are ‘too big to fail’. By allowing people and companies to bypass the banks and pay each other directly using central bank money, a significant amount of risk would be removed from the financial system. Also, as more people chose to store their funds at the Bank of England in Digital Cash Accounts, the less need there would be for the government to guarantee the deposits created by banks.
- It can encourage competition in payment accounts: At the moment it’s extremely hard for a new bank or technology firm to start providing current/checking accounts to compete with the big banks. This is partly because it is very difficult to get an account at the Bank of England. The regulatory framework we’ve proposed in the report [LINK] would allow much more competition, and remove the banks as ‘gatekeepers’ to the payment system. This is quite important to Positive Money, because banks are currently able to argue that they deserve special treatment (i.e. being allowed to create money) because they provide the payments system and savings and loans. But the peer-to-peer industry is now competing with the banks for their lending business. We need other firms to compete with banks for their payments business. Once it becomes clear that the functions of (1) payments and (2) savings and lending, can by provided by completely separate companies, it becomes much harder to argue that banks should be allowed to retain this unique business model which combines both functions in a way that enables them to create money.
- It can recapture some of the seigniorage on money creation: When the Bank of England issues paper money, the proceeds from issuing that money are greater than the costs of printing it, and the profits go back to the Treasury, reducing the amount the government has to tax or borrow. But since it is currently banks that create electronic money, the government loses the seigniorage on this money. By issuing digital cash, some of that seigniorage would be recaptured.
It’s looking quite likely that some form of digital cash will be implemented at some point in the future. Last week, a deputy governor of the Bank of England announced that it would be starting a year-long consultation about who should have access to the electronic accounts at the Bank of England. At this point, the Bank of England is probably thinking about simply allowing a wider range of financial firms to have access to central bank accounts, which would be an improvement on the current situation, but not good enough. We think the Bank of England can go further to make digital cash accounts available to all citizens.
For more details, read the full report here.
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